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Bond fund basics: Duration

The concept of duration in the world of bonds is far from intuitive. Technically, it represents a period of time, expressed in years, that indicates how long it will take an investor to recover the true price of a bond, considering the present value of its future interest payments and principal repayment.

Duration is useful in measuring a bond fund's sensitivity to changes in interest rates. The longer the duration, the more a bond fund's price will fluctuate when interest rates change.

To estimate how a change in interest rates can affect the share price of a bond fund, multiply the fund's duration by the change in rates. If a fund's average duration is 2.5 years, a 1-percentage-point rise in interest rates would lead to an estimated 2.5% decline in the share price. A 1-percentage-point decline in rates would cause an estimated 2.5% rise in the share price.

In the chart below, move the slider or tap the screen to see how changes in interest rates can affect the principal value of three hypothetical bond funds.

INITIAL VALUE $1000

DURATION (Years)

$1000

$1000

$1000

2.5

6

12

Hypothetical Short-Term Bond Fund

Hypothetical Intermediate-Term Bond Fund

Hypothetical Long-Term Bond Fund

CHANGE IN INTEREST RATES

  • -2%
  • -1%
  • 0%
  • 1%
  • 2%

This hypothetical illustration does not represent the return on any particular investment.

Notes

  • All investing is subject to risk, including the possible loss of principal.
  • Investments in bonds and bond funds are subject to interest rate, credit, and inflation risk.
  • Bond funds are subject to the risk that an issuer will fail to make payments on time, and that bond prices will decline because of rising interest rates or negative perceptions of an issuer's ability to make payments.
  • Past performance is not a guarantee of future results.

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